It’s official. The Federal Reserve re-turned to the monetary policies of the World War II years and is asking Congress to resurrect the fiscal policies of that period.
At the end of August, Fed Chairman Jerome Powell confirmed the Fed’s policy for the long term is to keep interest rates very low and ensure the markets and economy have all the liquidity they could need. The Fed isn’t going to worry about inflation for some time.In fact, the Fed essentially raised its inflation target. Now, the Fed isn’t going to try to contain inflation until the average over a number of years exceeds 2%.
That means inflation will have to be above 2% for an extended period to offset the years inflation has been below 2%. Only then will the Fed consider tightening the money supply.This is no surprise to my readers. After the pandemic hit, I said that would be the Fed’s policy, whether it explicitly said so or not.
I presented the details of the World War II policy and explained why that would become the policy for 2020 and beyond in the April 2020 edition of the Retirement Watch Spotlight Series of online seminars. (You can sign up for the Spotlight Series on the Retirement Watch website or by calling 1-800-552-1152.)
The Fed will be buying government bonds, mortgages and other securities in the markets as needed to keep short- and intermediate-term interest rates low. For the most part, the Fed will let longer-term rates fluctuate. But when longer-term rates rise enough to threaten economic growth, the Fed’s likely to buy some longer-term bonds to bring those rates down.
This environment should continue to be good for inflation hedges, such as gold and Treasury Inflation-Protected Securities (TIPS).
The policy also should be good for stocks in general. The money the Fed uses to buy bonds and mortgages is likely to finds its way to other markets and the economy. Because interest rates on bonds are so low, investors will seek higher returns in stocks and other investments. Of course, bonds aren’t going to deliver much of a return. After inflation and taxes, many bonds and similar investments will generate negative real returns.Despite the Fed’s dedication to supporting the economy and stock market, there are some risks.
One risk is that the Feds policies become ineffective. The combined effects of the pandemic as its drags on and the lingering effects of the financial crisis already limit growth. The large number of people who are receiving reduced unemployment compensation could cause a down-ward spiral as businesses that are open experience lower sales.
A bigger risk is the contraction in fiscal policy. Congress responded quickly in the early stages of the pandemic, enacting the largest fiscal stimulus policy in the world. That helped maintain retail sales and contained the decline in economic growth.
But the stimulus measures expired at the end of July, and Congress hasn’t agreed to new legislation. The latest data indicate the recovery has slowed and household spending is faltering. We’re going to find out how important the fiscal stimulus is to the economy.
Of course, we still need to be wary of issues that existed before the pandemic, such as the election, trade wars and other geopolitical conflicts.We don’t have to change our portfolios in response to the announcement of the Fed’s policy, because we anticipated it. We sold nominal bonds in favor of preferred securities and, more recently, TIPS.
We’ve owned gold for a while and increased our allocation. I remain cautiously optimistic about global growth stocks. But we have to monitor how the reduced fiscal stimulus and global spread of the virus affect economic growth. The course of the coronavirus is the major factor influencing the economy and markets. Trends would change rapidly if an effective vaccine or treatment is developed.